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Hedge-To-Arrive At Corn Profits

Jeff Davis didn't wait for this year's extraordinary run-up of corn prices at harvest to get his crop marketed at near $3/bu. With the huge demands for more ethanol production, strong livestock markets and fewer corn acres on the horizon, he made sure that $3-corn was locked in early.

The western Kentucky grower used early hedge-to-arrive (HTA) contracts to book $3-area corn for 2006 and some $3.20 or above for '07.

Cunningham, KY, is only a few miles from where the Ohio and Mississippi rivers merge. That provides Davis and his partner-brother Roger with a good market, depending on the availability of barges, which is still being affected by a post-Hurricane-Katrina backlog.

“Corn marketing is more strategy than emotion,” says Davis. “We sit down and write a marketing plan. We use a marketing consultant to make sure the timing is right and to actually carry out our plan.”

The Davis' marketing plan normally includes their ability to store corn in some 400,000 bu. of on-farm storage capacity. Their expected production and the bushels they expect to sell in the fall are also at the top of the list. “We always use a conservative projected yield,” says Davis, adding that marketing normally begins a year or more ahead of harvest. “In normal years, by the time we get to harvest, the corn not already sold is that which is above our projected yield.”

For 2006, he was slower to pull the trigger on the majority of his corn early. “I was bullish about this year's price and the next few years',” he says. “There are too many factors that should lead to higher prices for corn.”

With his bullish attitude, Davis says that only 20% of the '06 corn had been marketed before mid-June. “That is as light as we've ever been,” he says. “Only 25-30% was marketed by early July. We got an average price of $2.95 using HTAs.”

With an HTA, he can lock in a futures price with an elevator or other delivery point without establishing a basis. He agrees to deliver the corn at that price, but is not required to make actual futures trades. Thus, he is not subject to margin calls on a straight HTA. He can also set the basis any time he wants.

Again, his ability to store large quantities of grain gives him a better position in setting HTAs. That's what helped him get some '07 corn marketed in early '06, even though all of his '06 crop had not been priced. He was ready to market some '08 corn as well if the market swung up again.

Further '06 marketing took place in early July. After a seasonal drop in corn from the $2.80s seen in May to below $2.60, the Davises decided it was time to get the majority of their unstorable corn sold in the event seasonal price trends took prices even lower heading into harvest.

“We are 80-100% sold at an average price of $2.62-2.65 on corn we can't put in our bins,” he says.

But for production they can store, Davis feels the sky could be the limit for prices this year. “I still think we could see a 50-60¢ run-up on prices,” he says. “We'll probably market the remainder of our '06 corn then. And we will definitely sell some more '07 and '08, probably using HTAs.”

As for '07 marketing, Davis has about 25% of his crop marketed at $2.70 and $3.08 HTAs based on December '07 futures trades made beginning last spring.

He also took advantage of stout '08 prices on about 5% of his '08 crop, going with a $3.24 HTA backed by a December '08 $3.40 call option sold for 36¢. That option sale added to his potential price. It will likely be lifted if the price reaches the $3.40 level. The distant marketing moves likely wouldn't have been made if he had not had sufficient storage and the ability to make a good crop.

Remember, the upside potential for a set HTA contract is through an increase in basis, since a futures price is established in the contract when it's made. Cash prices and futures prices usually converge near a contract's expiration. If basis levels narrow, there is an increase in the overall price received by the grower, depending on when he establishes the basis level.

With any type of price involving futures and basis, there is also downside price potential. If the basis doesn't narrow as the contract expiration nears, or if the futures price goes above the established HTA price, that additional price increase is lost, unless additional options trading or hedging is involved.

The mention of HTAs undoubtedly brings up some unkindly memories of the mid-'90s for some. That's when several grain elevators, growers and other entities got caught up in some bad HTA rollover deals. Unusually high corn prices caused the problems, and there wasn't enough corn to rollover to take advantage of multi-year marketing. Losses were in the millions. There were even some indictments and nasty court cases.

Bob Wisner, Iowa State University grain marketing economist, says HTAs can be a good marketing tool — if they're not misused.

“HTA contracts range from relatively simple, low-risk non-rolling versions in which basis risk is the main area of risk exposure to more complex types,” he says. “The mid-1990s problems occurred with much more complex types that allowed producers to roll (change delivery dates) and permit the next year's crop to be priced initially with old-crop futures contracts,” he says.

In cases like those seen in the HTA-gone-bad years of 1995 and 1996, Wisner says these contracts were used to price several years' production through an initial position in old-crop futures.

“Contracts that involve inter-year rolling of HTAs have extreme risk exposure,” he warns, “and after the 1990s experience, that won't be allowed by the elevator. Multi-year rolling HTAs are extremely high-risk speculative instruments, and can be much riskier than speculating in the futures market. They are neither price protection nor risk management tools.”

For growers wanting to use HTAs or other forward pricing, but who lack storage or are afraid of not being able to deliver corn, soybeans or other grain, crop insurance agents insure lost yields at the harvesttime replacement value.

In the program, a grower can secure insurance coverage based on his county's average yield. Craig Rice, Risk Management Agency (RMA) regional director, St. Paul, MN, says these revenue protection products can provide a security blanket for a premium that varies from region to region.

For example, a grower in a strong corn production county in central Iowa may be able to protect 65% of his historical 165-bu. yield for 4¢ for every $1 of coverage. But a grower in a fringe production area of northern Minnesota might have to pay 18¢ for every $1 of coverage, says Rice.

An RMA CRC quote may be obtained by going to www3.rma.usda.gov/apps/premcalc, although an exact premium for your farm will have to be made through a crop insurance agent who looks at your yield history and location.

Also, regional cooperative Extension economists, private marketing consultants or grain handlers can help outline HTA and other marketing programs that may be good for a particular area.

Meanwhile, Davis stresses that his bullish attitude can quickly change if the ethanol boom goes bust. “I am very optimistic in the short term,” he says. “If oil prices suddenly go down, they could drag ethanol prices with them. There wouldn't be near as much loyalty to ethanol production as there is now.”